Indexology^® Blog

At the heart of the active versus passive management debate lays the theoretical underpinning that the average return of both actively and passively managed assets must equal the aggregate market, thereby making it a zero-sum game. Since the costs of active management typically exceed those of passive management, the average actively managed dollar will underperform the average passively managed dollar after accounting for costs (Sharpe 1991). Over the past few decades, this debate has inspired many passionate believers on both sides, exhibiting its staying power as one of the more hotly contested financial theories.

As a way to keep score of the ongoing debate, S&P Dow Jones Indices (S&P DJI) started publishing the S&P Indices Versus Active (SPIVA®) Scorecard for the U.S in 2002. The scorecard measures the performance of actively managed domestic equity funds across various market capitalizations and styles, as well as fixed income funds, relative to their respective benchmarks. Results can vary on a year-over-year basis due to market conditions, with indices losing out to active funds in one year but winning in a subsequent year. However, the scorecard shows that over a longer-term investment horizon, most active managers have a difficult time outperforming their respective benchmarks. The five-year performance figures show the consistent losing pattern across most equity and several fixed income categories. In addition, the report dispels myths surrounding “inefficient” markets such as small caps and the emerging markets equities, the two areas in which active investing is perceived to offer opportunities due to the mispricing of securities.

Join us for a webinar on Wednesday, “Are Low-Cost, Passively Managed ETFs the Solution to Performance Challenges?” for an opportunity to hear in-depth discussion around active versus passive debate and the SPIVA Scorecard results from various global markets.

During festivals such as Diwali, the demand for gold in India increases because it is considered auspicious.  Traditionally, people invested in physical gold bars, coins and jewelry.  However, after the introduction of the gold ETF, the option to invest in gold also became popular.  There was a huge growth in the assets under management for gold ETFs compared with ETFs in other asset classes.

Investors purchased gold as a way to preserve value and hedge against inflation and recession.  Gold was in a bull run until the year 2012, and the average asset under management in gold ETFs peaked at INR 119 billion in Q1 2013, but since then it has declined.

Exhibit 1: Average Assets in Gold ETF’s in India 

Source: Association of Mutual Funds of India.  Data as of Sept. 30, 2014 

The Federal Reserve introduced tapering after confidence of the sustained improvement in the U.S. economy was restored.  Tapering led to the strengthening of the U.S. dollar, which exerted downward pressure on the price of gold.  The import restrictions in India, the second largest consumer of gold, exacerbated the situation.

The Indian government and the Reserve Bank of India introduced a series of measures in 2013 in an effort to curb the import of gold and improve the current account balance of payments of India.  The introduction of the 80:20 rule, under which 20% of the imports must be re-exported, and an increase in import tariffs has reduced the amount of gold imported, and it has increased gold’s premium in the local market compared with that of the global market.

Looking at Exhibit 2, we can see that the S&P GSCI^® Gold TR, which measures the returns accrued from investing in fully collateralized gold futures contracts, has been in a declining trend.  It has lost nearly 8.91% and 9.78% over the one- and three-year periods ending in September 2014, respectively.

There has also been a shift in the sentiment toward investments in equity and bond markets because of higher returns.  These all are included as some of the reasons for the decline in the price of gold after the 11-year bull run.  However, with the ongoing economic crisis in Europe and among the emerging markets, gold may still benefit as a safe haven hedging tool.

Exhibit 2: S&P GSCI Gold TR 

Source: S&P Dow Jones Indices LLC.  Data as of Oct. 15, 2014.  Charts and tables are presented for illustrative purposes.  Past performance is no guarantee of future results.

The market action in US stocks and Treasuries last week, especially on Wednesday, may be an experience that many investors would like to forget.  On Wednesday volume in US treasuries set a record as yields collapsed, stocks nose-dived and VIX topped 30 after opening the week at about 20.  As horrifying, or exciting, as it was, there may be lessons buried in the numbers.

Rarely does one specific event cause this kind of market turmoil; rather many sources of investor anxiety crowd together.  Among the protagonists were Ebola fears, slow European economies, weak US retail sales, and the Middle East.  Over-riding all of this was the growing conviction that the markets were surely in a correction, if not something worse, and no one would even guess where the bottom might be. As downward momentum gains strength it persuades investors that they should be getting out.  When that happens, investors want to sell the dogs — their least attractive unwanted and illiquid holdings.   But these are exactly the positions that are hardest sell if there is a market and impossible to unload if the market vanishes into the turmoil.

The response? Investors have no choice but to sell what they can sell, not what they want to sell.  What can they sell in the midst of the storm?  Anything in the deepest markets:  either US stocks or US Treasuries.  Last week the focus of fear was on equities and the answer was selling US stocks.  Hedging also may have been driving the market.  Equity investors who wanted a hedge for down side protection would have chosen the liquidity in S&P 500 futures.  Short futures positions can be read as a sign that stocks will fall further and may add to downward momentum.

While Wednesday’s action in US Treasury notes was more of a buying panic, the week’s events could be a hint of what might happen when the Fed finally does raise interest rates.   Some time, probably next year, the FOMC meeting notes will announce that monetary policy is being tightened and interest rates will rise.  Investors in a rush to sell unwanted bonds will find the only liquid market is 10 year Treasuries; they will be forced to keep junk bonds and sell, or short, treasuries. Others simply looking for a hedge will also short treasuries.  Those illiquid unwanted bonds will then be re-priced at lower levels consistent with the falling prices on over-sold US treasuries.   Fixed income prices could cascade downward.  It has happened before in the early 1990s when the Fed tightened more aggressively than expected and mortgage-backed bond traders got caught in a rush to the exit.

In late August, as reported by the Wall Street Journal, Walgreens announced the departure of their CFO at the end of the current year. This news came after a significant cut in forecasts by $1.1 billion from the original $8.5 billion forecast in fiscal 2016 pharmacy-unit earnings. According to the Wall Street Journal, “Walgreens hadn’t factored in, among other things, a spike in the price of some generic drugs that it sells as part of annual contracts.” This illustrates an opportunity where the S&P Healthcare Claims Indices may have been utilized as a tool to monitor the changing costs of both medical and drugs. As evident in the cost chart below, generic drug costs tend to be quite volatile, with overall costs growing at times in excess of 20%. However, looking at utilization, we can see that growth peaked in January of 2013, and has been declining ever since.

To gain insight on generic drugs, one may look at Unit Cost Indices, which show that while brand name drugs continue to escalate in price steadily over time, the cost of generic drugs on a Unit Cost basis tends to be more volatile, even declining in price at times. Because both the utilization and average cost of generic drugs are driven by factors such as the end of the patent protection period on brand drugs, high volatility is likely to be an inherent characteristic of generic drugs. By utilizing the S&P Healthcare Claims Indices, one may be able to better manage expectations for future changes in healthcare costs by studying recent trends.

Over the past two decades, real estate investment trusts (REITs) have emerged as a popular and efficient way for investors of all stripes to access the real estate asset class. Strong long-term total returns, combined with other key investment characteristics such as liquidity, high dividend yields, their potential to increase diversification and to hedge against inflation have contributed to the appeal of REITs.

Source: S&P Dow Jones Indices LLC; Barclays Capital. Data as of Sept. 30, 2014. Returns are based on total return index levels. REITs, Stocks, Bonds and Commodities are represented by the Dow Jones U.S. Select REIT Index, the S&P 500, Barclays Capital U.S. Aggregate Index and the S&P GSCI, respectively. Charts and tables are provided for illustrative purposes. Past performance is no guarantee of future results

REITs were established in the U.S. in the 1960’s and have evolved into a mature asset class here. However, outside of a handful of other early adopters such as Australia and Canada, the REIT structure had not been widely adopted globally until recently. In the past several years, REITs have gained traction globally as more and more countries around the world have enacted legislation authorizing REITs. In 2000, only 6 countries were eligible for SPDJ REIT indices. Today, twenty four are eligible with recent growth concentrated in Europe and Emerging Markets.

Source: S&P Dow Jones Indices LLC. Data as of Sept. 30, 2014. Charts and tables are provided for illustrative purposes.

Although the U.S. remains by far the world’s largest REIT market by value, it now represents only about half of the global opportunity set for listed real estate securities.

To learn more about the REIT structure, their evolution as an asset class, and their investment characteristics see our paper REITs: Making Property Accessible.